Does Success Breed Failure? The Rule of Government Neglect

I keep beating this horse, but the current economic situation continues to need serious government attention. Increasingly, we are told the worst is over. If that's true, thank fiscal policy and the alert and intelligent Ben Bernanke for acting quickly.

But the worst may not be over. House prices keep skidding. An analysis of post-war financial crises since World War II suggests that the rise in house prices that preceded this one was significantly greater than the others. That means there's more room to fall. And if house prices fall a lot more, there will be more defaults and foreclosures, and more mortgage debt losses for the financial institutions.

Now, we are told by the New York Times that the Republicans are resisting a package to stem the defaults and perhaps ease the decline in house prices. Their constituency, they think, wonders why the government is bailing out profligate homeowners. They smell political advantage.

They are also falsely encouraged by the current pause in alarm. Maybe the crisis is not that bad after all, they slyly say. As I've said before, I hear that lots now. And as the Democratic House biggie Barney Frank says, it's hard to get the Republicans to do something they don't like, anyway, which is to take government action.

Where does that leave a potentially even bigger problem? That is, the re-regulation of finance. Paul Krugman wondered recently whether the impetus for needed regulation is already diminishing. That's what happened in 1997 and 1998 after the Long-Term Capital Management Crisis. A lot of talk and then no action. Where was the Clinton Treasury? In today's Times, Andrew Sorkin interviews a major hedge fund operator who is asking for serious regulation. I hope he gets back to him a year from now.

In a piece the forthcoming Challenge Magazine, which I edit, the London School of Economics professor, Robert Wade, makes the case well. The efficient markets theory was put to a serious test in recent years and it failed. The problem areas were exactly where there was no regulation. Competition was not the great regulator, as free market enthusiasts insist it is. Instead of costs rising as markets got riskier, costs of investing fell. Financial markets are susceptible to mob psychology.

The free market prevailed and it failed.

What do we need? Capital requirements, exchanges to trade the new securities, broader oversight? The list is rather long and deep because the neglect under the weight of a purist free market ideology has been severe. But neglect will return if the government succeeds in minimizing the crisis. People will say the markets worked, they adjusted on their own -- and they would be wrong. Call it the rule of government neglect.

This should be a bigger campaign issue than it is. We have an election coming in November and Congressmen should be elected who support serious re-regulation of finance. But with jobs at hedge funds waiting for those leaving government, it may be a losing battle. That's really the vicious circle. The potential regulators and the regulated are one and the same.

In the end it may be up to the next president. The candidates should be talking about financial re-regulation more.

Comments

[JoeBlough]

This issue is the only time I have ever agreed with Bush. I think it is important to get the price of housing down to the level it should always have been. Sustaining bubbles with bailouts is bad policy. We need to reduce prices so that regular Americans who live within their means can buy their first house. To bail out the speculators and con artists is a slap in the face to all Americans. We must stop this financial appeasement.

[Herrington]

It is always the flaw. Things appear to be working, therefore there is no need to change how they work. Call it "don't fix it if it aint broken". But the question is for whom things are broken.

The investment banks are fine, bailed out by promisory promiscuity. The citizens eat the effects of malfeasance. Sure there were people borrowing that should not have been borrowing on those terms. But the resolution excuses the banker and not the borrower when both were at fault.

In a nation that increasingly must borrow against Friday's paycheck to meet Wednesday's needs, one must soberly consider that usury is alive and well even after being condemned since before the time of Christ.

[Henry]

A significant slice of the current problem (subprime crisis) had to do with speculative loans used to flip properties and make nice profits. There are easy solutions to this: make speculation in single family loans illegal or tax the gains on such transactions at 72%, or require downpayments to be 33%. The range of options is immense and the sooner implemented, the better.
We've been here before, we'll be here again. The more things change...the more they remain the same.

[burnt]

"...the current economic situation continues to need serious government attention."

If you believe that the current economic situation is anything but the result of careful planning and implementation by the current administration, you need to sit down and reexamine the basis of your conclusions. Start with "The Shock Doctrine" by Naomi Klein.

This government is not going to do anything about the problem... except fan the flames. By the time Obama has the economy dumped into his lap, CheneyOilCo will have achieved most all of its intended class destruction and Treasury pillage.

[not one of the sheep]

You can't seriously believe the swill you just spewed. After 6 years of incompetence by the repubs now we have had 2 years of dem congress rule that has achieved near total destruction of the economy. Both parties have shown brilliantly that they have no regard for anything but lip service, ego boosting, finger pointing, and absolute stupidity. Get off the hate train and realize that it's time for all the clowns we call congress and the administration to be replaced so we can have people who will represent us without jamming excess government down our throats.